Ethics & stockbroking in a post FOFA world

My first brush with a lack of ethics in financial advice was some years ago, before I worked in the industry. I’d received an inheritance that was to form the deposit for my first home – a friend recommended a mate, who could “get better rates than the bank”. At a time when bank deposits were offering circa 7%, I was offered 18% – and like many who don’t know better, I thought “why not?”.

Despite asking several times where my money would be deposited – and being reassured it was a bank deposit – it was in a market linked product with a large life company. The agent’s 10% commission had not been disclosed, nor had the actual product details. It was down to a friend in financial services who told me to “get out now” and helped me write to the company’s chairman, that saw me get my money back. In fact, in the two weeks it took to get my $20,000 investment returned, it magically grew to $22,500 (put that down to a whole lot of butt covering by the life company and agent!)

Since that time there’s been a raft of legislation introduced to ensure that the ignorant aren’t conned. Those fat upfront commissions came down from an average of 10% to zero. Trails disappeared. Conflicted remuneration became a thing of the past. Reputedly.  

Some people are easily fooled (and yes, I hold my hand up high) by the lure of better returns than those offered by banks or other investments. It comes down to trust – we expect that our service providers will always act in our best interests, whether they be accountants, doctors, dentists, lawyers, financial advisers or stockbrokers. We don’t expect them to breach our trust and behave in a way contrary to our best interests.

Enter the Future of Financial Advice (FOFA)

In financial services, ethical principles are enshrined in law. Although there were a raft of earlier laws, the Future of Financial Advice (FOFA) reforms, implemented in July 2013, were conceived to improve the transparency and access to financial advice for all Australians. FOFA introduced the concept of ‘best interests duty’ to ensure all parties providing financial advice act in the best interests of clients, provide appropriate advice, warn the client if the advice is based on incomplete or inaccurate information, and prioritise the client’s interests.

It also encouraged advisers to separate advice fees from transaction fees, to distinguish the value of investment advice from the execution of that advice e.g. brokerage.

While the majority of individuals providing advice do the right thing, the road to FOFA was littered with case studies of financial advisers, brokers and bankers who acted in their own interests and not of those clients; and despite FOFA, lack of ethics prevails in a small cohort. Not a week goes by without the trade press headlining the latest breach and just last week, a big four banker was jailed for faking documents that gave loans to the elderly, against their homes. The money was then invested in a now failed property scheme – for which he received an alleged $15,000 commission (per investment). Conflicted remuneration, much?

The US experience

Of course, poor behaviour and the need to regulate it is not an Australian phenomenon. In April 2016, the US issued a new law that required financial advisers handling retirement accounts to act as ‘fiduciaries’. Advisers now must have clients sign a document called a ‘best interest contract’ that establishes a fiduciary relationship between the two. Once in place, any advice provided on retirement savings must meet a standard that is about client needs, and not what makes the adviser the most money.

Of course, since the new president took office, this ruling is among the many thrown into the air and, according to US Investment News, Trump has unleashed mayhem on the retirement advice industry.

“The world is upside down,” said Knut Rostad, president of the Institute for the Fiduciary Standard. “Uncertainty and ambiguity will be the watchwords of the day.”

Whatever we think about the implementation of FOFA and other regulations in Australia, while there might be argy-bargy in parliament, there won’t be an arbitrary decision by an individual with a questionable agenda.

Ethics and listed securities

Listed securities are being recommended by a growing number of advice professionals – brokers, financial advisers and accountants. The huge growth in demand for exchange traded products has largely driven this trend.

Working with listed securities presents some additional potential breaches for the less ethical. Although less likely with ETPs than individual securities, it’s incumbent on all in the industry to be aware of the laws that underpin working in the listed environment and not breaching them – even if at the clients’ request.

Client’s request? Yes that would be the old chestnut, insider trading. It might be a client’s father’s best mate works for a company that is subject to a takeover not yet announced to the market. Acting on that knowledge is illegal, for both parties.

Many in the industry believe there is more insider trading going on than is prosecuted – even in this day of immediacy of information. One case that caught my eye was the scheme dreamt up by two young grads. One, working for the ABS, would send his mate unpublished stats; labour force, new capital expenditure, retail trade and building approvals data. His friend, then working for a big bank, used the sensitive information to trade in foreign exchange derivatives. They made more than $7 million before they were caught.

It comes down to a level playing field – why should one or two parties profit for knowing something before others? As well as breaking the law, it’s a breach of ethics.

Another important rule is that which focuses on achieving the best execution for clients; for retail investors, best execution is defined as ‘best total consideration’ – for buy orders, paying as little as possible, for sell orders, receiving the best price possible.

Best execution applied to all listed securities, whether a share, an ETF or a listed investment company. It applies to trades executed via ASX or Chi-X, with additional for trading derivatives.

Ethics in financial advice is about providing sound advice that is in a client’s best interests and will help them achieve their financial objectives. It is also about making sure the client understands the advice and relevant investment recommendations.

Over time, the provision of sound advice, good communication and an ethical approach to business will pay dividends to advisers, in the form of positive client relationships and business growth through referrals from satisfied clients.

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